by Franklin J. Parker, CFA
The Summary
- The Bottom Line. It is my view that investors could see an upside surprise from the Fed next week. While markets have priced-in a 0.75% rate hike (which I think is likely), I believe the central bank is also likely to offer more dovish guidance on the path of future hikes. Furthermore, the economy has remained fairly robust to these hikes and earnings growth is likely to continue through the end of the year. I would caution investors against being overly pessimistic at this moment.
- About 20% of the S&P 500 has reported earnings for Q3, and it looks like companies will report around 3% profit growth over last year. Profit margins have started to show signs of pressure as companies are having more difficulty passing along cost increases from inflation. 3% profit growth is not great, but it is also not recessionary, and analysts continue to expect profit growth through year-end.
- This week is a pretty busy one for data. Global PMI’s posted today—offering some insight into the health of global manufacturing and services—both posted a slight decline. Consumer confidence and new home sales both post this week, as do durable goods orders, and an advance reading on Q3 GDP. We also get personal consumption expenditures, which is the Fed’s preferred measure of inflation. Since the Fed meeting is next week, investors will be interpreting this data through the lens of Fed actions—which means that bad news is good news.
The Details
In my upcoming book, I recount a story from early in my career. The firm I was with rolled out some new financial planning software. Responding to my question, the trainer indicated that I could just put in long-run averages for my inflation assumptions, that “it really doesn’t matter too much anyway.” As I played around with the tool, however, I found that this was flat wrong—inflation assumptions mattered quite a lot!
Indeed, over the course of 20 years, the difference between a 3% inflation rate and a 5% inflation rate is the difference between achieving your goal and having only about two-thirds of the money you need! Said another way: you need almost 50% more money in the 5% inflationary scenario than in the 3% inflationary scenario.
The details of this are covered in my book, so I won’t recount them here. The point is, the damage done by high inflation cannot be understated. Furthermore, getting assumptions like this as right as possible when running financial planning scenarios is critically important. It is not enough to say “yeah, 3% is close enough.” Time and effort spent getting those expectations as right as possible is time and effort well spent!
So, while investors are rightfully reeling at the recent market selloff, inflation does considerably more damage, long-term, than do these short-term market downswings. Getting inflation back down is critical for investors with goals to achieve. And it is especially important for investors and practitioners who underestimated inflation over the coming decade.
Chart of the Week
There is a strange dichotomy in markets at the moment. On the one hand, talk of a recession is everywhere. On the other hand, analysts don’t see a recession in their earnings forecasts. European earnings estimates 1-year ahead of now indicate expectations for almost 5% earnings growth. Certainly not great, but also not recessionary. We see something similar in the US earnings growth outlook. Analysts expect mid to low single-digit earnings growth through next year. Again, not great, but not recessionary.
It can be easy to get caught up in a narrative. As investors, we should always let the data drive our narrative. At the moment, the data does not indicate that fear is warranted. Caution, certainly, but recessionary fears may be overblown—at least for the moment.
Of course, as the data changes, so do our minds.
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